A Simple Way to Fight the “Cleaver” of Inflation

2022. This is the year the world (for the first time in a long time) again became familiar with the harsh realities of the economic phenomena called inflation. And like with so much else, everyone seems to have an opinion.  Some economists say inflation is here to stay. Others, that it will go away.  There are arguments about whether inflation will drop, stay steady, or rise. There are think tanks making the argument that inflation is good and others that it is harmful.  The reality: no one has a crystal ball.

It is prudent, therefore, to ask: “If inflation is here to stay, as it could be, what are some ways to hedge against the cleaver of inflation?”

THE SEARCH FOR YIELD vs. THE SEARCH OF INCOME GROWTH

Many people invest looking for the highest yield – in the past few years this might look like selecting an investment paying 7% or 8% with little-to-no income growth.  That is a fine way to invest, but finding the highest yielding investment often ignores the realities of an inflationary environment.  We have been in a period over the last 40 years where interest rates have declined.  We are living in a new normal.

If inflation is 8%+, this means that you need your income to grow at more than that number to maintain the same spending power.  Income growth can become the significant factor in fighting inflation. A high yielding investment will become less and less valuable without income growth. 

Where can you find investments growing income at more than 8%-9% per year?  You need look no further than a select group of high-quality, blue-chip, multinational companies with a history of strong dividend growth. 

Take for example a utility company that is part of the S&P 500 (the S&P 500 consists of roughly the 500 largest companies in America). In 2012 its dividend was $0.60 and its share price traded between $15.00 and $18.00. It yielded 3.47%.  In 2022 its dividend is $1.70 and its share price ranged between $68.00 and $93.00 due to this year’s market volatility. It yields approximately 2.20%.  While this company has a lower yield than some other investments, shareholders received a “pay raise” that outpaced inflation each year – from 60 cents ten years ago to $1.70 today. Their spending power went up.

Another example is technology company that is part of the S&P 500. This year shareholders are receiving $16.40 per share yielding 3.8%.  A decade ago? It was paying 56 cents per share for a 1.7% yield. It has increased its cash-flow to its shareholders by way of a dividend by 40% compounded annual growth over those 10 years.

There are companies across all sectors of the S&P500 that fit this same pattern.  The point is that each year, over the decade, shareholders received a “pay raise.” We can use real estate as an analog. Imagine owning a rental property in which you have a AAA tenant and guaranteed price escalators in the rental contract.  If you had this setup, each year you would be confident that the rent would be paid on time and that next year the rental income would grow.

A few months ago, the financial world was told inflation was “transitory” by some of the smartest, well informed, and most educated economists in history.  At PFS Financial, a foundational principle that guides our decision making is that “no one can predict the future.”  Thus, we follow our rules-based approach and to make strategic, tactical shifts as new data emerges. 

For this reason, we suggest considering dividend-growth companies as a tool in your portfolio to fight the realities of inflation.

DISCLOSURES

The information given herein is taken from sources that IFP Advisors, LLC, dba Independent Financial Partners (IFP), IFP Securities LLC, dba Independent Financial Partners (IFP), and its advisors believe to be reliable, but it is not guaranteed by us as to accuracy or completeness. This is for informational purposes only and in no event should be construed as an offer to sell or solicitation of an offer to buy any securities or products. Please consult your tax and/or legal advisor before implementing any tax and/or legal related strategies mentioned in this publication as IFP does not provide tax and/or legal advice. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. This report may not be reproduced, distributed, or published by any person for any purpose without IFP’s express prior written consent.